How Strong Is Bullish Sentiment?

Friday September 22, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Inventories decline in second quarter, but next steps uncertain

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- Global oil inventories declined at a rate of 0.9 million barrels per day in the second quarter, a steep drop after several years of increases.
- Refined product stocks also saw a dramatic decline, evidence that the oil market is moving towards rebalance.
- But the declines could be short-lived - U.S. shale production is rising and seasonal demand is waning.
- Also, as Bloomberg Gadfly notes, OPEC's data is often unreliable - OPEC producers could be supplying the market with much more oil than they report. Falling production figures are misleading because OPEC's exports have remained at a much higher level.
- The situation gets worse next year as shale output is expected to continue to grow and OPEC grapples with how to handle its extension.
- The sharp decline in inventories in the second quarter could be a one-off.

2. Frac sand miners hit by sand glut

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- There is a land rush going on in the Permian Basin - for frac sand.
- The WSJ reported that a long list of sand mines are opening up in Texas, allowing drillers to source sand much closer to home rather than buying from Wisconsin and shipping it by rail.
- According to Jefferies, there are 18 sand minds that are either proposed or in development outside of Midland, TX.
- Sand prices had tripled from $15 per ton in 2016 to $45/ton earlier this year. But as the sand mines come online, prices will likely crash.
- "There'll likely be many losers who jumped into the game a bit late," George O'Leary, an analyst at energy investment bank Tudor, Pickering, Holt & Co., told the WSJ.

3. Big Oil cleaning up

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- Greenhouse gas emissions from the world's largest oil companies are on the decline, according to Bloomberg, as are emissions from corporations in all sectors.
- 62 of the world's largest 100 companies have seen emissions steadily decline between 2010 and 2015, with an average of a 12 percent reduction over that time period.
- Cost effective renewable energy is a big reason why. "We're seeing renewable energy becoming more and more competitive opposite fossil fuels like coal," Peter Terium, chief executive officer of the German power generator Innogy SE, said at the Bloomberg New Energy Finance conference on Monday.
- Oil majors are cleaning up too. Bloomberg says that ExxonMobil (NYSE: XOM), Royal Dutch Shell (NYSE: RDS.A), Chevron (NYSE: CVX), BP (NYSE: BP) and Total SA (NYSE: TOT) cut their emissions by an average of 13 percent between 2010 and 2015.
- The reduction is also a reflection of a shift towards a heavier natural gas-to-oil production profile for the oil majors.

4. U.S. exports interrupted by Harvey, but set to rise

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- U.S. crude oil exports have bounced around this year, occasionally topping 1 mb/d in a given week.
- Those flows were interrupted by Hurricane Harvey, but the restoration of the Gulf's export terminals has led to a swift rebound in oil exports.
- U.S. oil exports could rise beyond typical levels seen earlier this year because of the sudden wide spread between Brent and WTI, a spread close to $6 per barrel, the largest in two years.
- That makes U.S. crude significantly more attractive than oil from elsewhere, and the discount is wide enough to cover higher transport costs from the U.S. to Asia.
- Experts see maximum U.S. oil export capacity at about 1.8 mb/d. "We're going to really test that number over the next few weeks, because we have excess barrels we need to move out," Stephen Wolfe, senior analyst at Trafigura Group, told the WSJ.

5. Commodity sector on the upswing

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- Commodity prices of all stripes are set for the best quarter in more than a year, according to Citigroup.
- "Commodities have hit their stride since the start of the third quarter and are set for a sterling performance for the rest of 2017, particularly given stronger incentives for investment inflows," the bank said in a report on Wednesday.
- Chinese demand has helped spur price increases for metals. Also, China has led a pollution crackdown, hoping to knock out inefficient and dirtier suppliers and reduce excess capacity. That has tightened the market for commodities such as iron ore.
- Citi says that the tightening oil market could also push up crude prices. "After a stormy summer, crude should end the year on a high," Citi said.

6. Backwardation points to oil market rebalancing

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- Brent futures have been in relatively sustained state of backwardation for several weeks, a sign that the oil market is much tighter than it has been in a long time.
- Backwardation - a state in which near-term oil futures trade at a premium to futures dated further out - reflects tighter market conditions today, while also reducing the incentive to store oil.
- In fact, storage facilities around the world are emptying out their product - Bloomberg reports that the South African storage hub is seeing inventories decline; floating storage is also dwindling; OECD stockpiles are down and converging towards average levels.
- "The market is selling inventories from everywhere," Marco Dunand, CEO of oil trader Mercuria, said in a Bloomberg interview.
- Perhaps the most bullish sign for oil is the sudden shift in the WTI futures curve into a slight backwardation. Up until now, Brent has demonstrated backwardation, but WTI has been stuck in contango - a bearish sign. But Bloomberg reported that just this week the WTI futures curve for May 2018 contracts flipped into a state of backwardation.

7. Fiscal breakeven prices for oil producers

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- OPEC producers have some of the lowest production costs in the world. Saudi Arabia can stick a straw in the ground and pump tons of oil at a couple of bucks per barrel.
- But production costs are very different from the prices needed for government budgets to breakeven. These "fiscal breakeven prices" are a much more important metric than strict production costs.
- And they are very high in many cases. Venezuela tops the list, needing $216 per barrel for its budget to breakeven. Needless to say, oil prices are dramatically lower than that, which helps explain the South American nation's horrific economic troubles right now.
- But even Saudi Arabia, the most financially powerful of the group, still needs more than $80 per barrel to breakeven. The de facto OPEC leader has been struggling with budget deficits, and has burned through cash reserves, taken on debt, and is planning a dramatic overhaul of its economy to fix the problem. The Saudi Aramco IPO should be seen in this context.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.